I have been a CPA for over 30 years focusing on taxation. I have extensive experience with partnerships, real estate and high net worth individuals.
My ideology can be summarized at least metaphorically by this quote:
"I have a total irreverence for anything connected with society except that which makes the roads safer, the beer stronger, the food cheaper and the old men and old women warmer in the winter and happier in the summer." - Brendan Behan
Nobody I work for has any responsibility for what goes into this blog and you should make no inference that they approve of it or even have read it.

FAIR Tax Abolishes IRS - Then What?

I’m always annoyed when I hears somebody arguing that if we made some tweaks in the tax system, we could abolish the IRS. Then we come to the FAIR tax, which actually explains, in detail, how its enactment allows for the abolition of the IRS. FairTax.org has quite a bit of information about the various aspects of the program, I’d suggest that you take a good look at it. It is probably worth studying. Here is the nutshell version of the Fair Tax Plan:

The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR 25 / S 122) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system.

Description unavailable (Photo credit: TheodoreWLee)

But You Still Need To Collect It

They’ve got that covered. The collection of the national sales tax will be handed off to the states, which will be paid a percentage. Most states already know how to collect sales taxes. So the abolition of the IRS is accomplished by substantially ramping up 50+ revenue departments (Besides the states, you have DC, the territories, and maybe some of the 500+ sovereign Indian nations). So when you hear that enacting the FAIR tax will save all that money we are spending on the IRS, it is not really happening. In an article available on the site Tax Administration and Collection Costs: The FairTax vs. The Existing Federal Tax System, the authors estimate that it will cost the states $9.66 billion to collect the Fair Tax and there will be a net federal savings of $9.38 billion. So there is actually a small increase in the government tax administration. The big savings projected are in the private sector compliance costs, which they estimate as being reduced by over $340 billion.

Progressive?

The proponents claim that the “prebate” concept makes the Fair Tax progressive. The “prebate” would be a monthly check on the amount of tax that would be paid by someone spending a poverty level income. They peg that at just over $11,490 per adult and $4,020 per child. So a single person who went through the proper registration would get a check for $220 monthly based on 2013 numbers. The check goes up by $77 per child. So all those Tax Court cases about who gets the exemption, child credit and head of household status – now we can have them about who gets the kid’s prebate.

That makes the tax progressive when it comes to consumption (at least overtly), but it is highly regressive when using income as a measure. Superficially, this system is Thomas Piketty on steroids. Most people spend most, if not more than their income, so among them, thanks to the prebate, the tax is progressive. Different story for the 1% who can invest most of their income. As a percentage of income, the amount they pay in sales tax will be much, much lower.

There is another odd quirk that adds a touch of regressivity to the Fair Tax. The social security tax will be repealed, but the wage reporting and benefit calculations will remain in place (although, there are hints that there might be other things in the works). Let’s imagine two guys, call them Joe and Harry. They each spend $80,000 per year, so they pay the same in sales tax. Joe makes $80,000 per year and Harry makes $90,000. Harry saves the other $10,000 for his retirement. Harry will also have a higher social security payout than Joe.

It is worth noting that the progressive income tax and the estate tax were put into place in response to Gilded Age inequality, when the government was funded mainly by consumption taxes.

Simpler?

Of course, the Fair Tax is simpler than the current income tax, but it would probably be easier to prune the bells and whistles from the income tax, if you can forgive a mixed metaphor, than to pass the Fair Tax. With an income tax, though, there remains a core complexity- What expenditures are being made to produce income, making them deductible in arriving at income? That core complexity remains in the Fair Tax. Vendors of all types collect the 23% on everything they sell, goods, services and rentals. They pay the tax on everything they buy, but then take a credit for the things that were used in the business. OK. So will the moderately sociopathic who own businesses ever buy anything that they don’t take credit for? Here is what the proponents have to say about that issue

Also, as registered sellers, they are subject to the possibility of being audited by the state. During such an audit, they will have to produce the invoices for all the “business purchases” that they did not pay sales tax on and will have to be able to show that they were bona fide business expenses. If they cannot prove this, then they will have to pay the taxes that should have been paid when the items were purchased, plus interest and penalties. The probability of being audited will be much greater than it is under the current system with its over 140 million tax filers. Under the FairTax, there will be less than 20 million businesses that will be filing sales tax returns and thus subject to the possibility of being audited. Thus, the probability of tax cheats getting caught will be much greater than it is today, making tax evasion riskier than it is today. Additionally, while the FairTax has much stronger taxpayer rights than does the current tax system, the FairTax legislation provides for a number of fines and penalties for noncompliance. It also authorizes a mechanism for reporting tax cheats and obtaining a reward.

So all the litigation that we have about deductible business expenses will remain relevant with the Fair Tax. Only the audits will not be conducted by one agency. There will be fifty or more with a possible race to the bottom in terms of how aggressive they are in order to make their states more business friendly.

Finally, one of the things that makes the Fair Tax simple is its comprehensiveness. All final consumption by everybody is subject to the tax. The income tax would be vastly simpler if Congress did not use it as the Swiss Army Knife of social policy using income tax credits and deductions to encourage various things, like research and historic preservation. What will stop them from doing this with a national sales tax? Gee, I could afford to pay $100 for that life-saving drug, but I can’t afford $123. Let’s exempt prescription drugs, but not birth control, unless its needed for some other condition – on and on and on.

Fifty plus revenue departments implementing a federal tax is a recipe for massive inconsistencies. Eventually, after horror stories about the aggressive New York and California auditors and the way too easygoing ones in Alaska, it will occur to somebody, that collecting federal taxes consistently across the country probably requires federal employees. Somebody feeling nostalgic might propose calling the resulting agency the IRS, but that probably will not happen.

Correction/Clarification

In the example I give for a hypothetical argument for a prescription exemption, I wrote that somebody would argue they could afford $100 but not $123. Actually, with the proposed Fair Tax it would be $130. The Fair Tax site keeps citing 23% to make it apples to apples to apples with an income tax, but as a sales tax the rate is 30%. The argument is that if you made $100 and paid 23% income tax you would have $77 to spend, so having no income tax and paying 30% on the $77 you spend works out to the same thing.

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The only Kool Aid being drunk is by the people who believe that it’s just fine for various people in government who are supposed to have their proper credentials flout that they don’t need them to continue in their fraud.

Progressive: The FairTax advertises proudly that is it even more Progressive (Socialist) than today’s Income Tax – on AFFT Board member claims it is more Progressive (Socialist) than returnin to 90+% tax rates.

The FairTax would FURTHER extend SS/Medi benefits to the NON-working poor by “inviting” the fraudulent reporting of SS Wages, by removing the tax “penalty” for doing so. FURTHER, because of the fraud in today’s Refundable Tax Credits. Would you expand on what yiou meant by, ” (although, there are hints that there might be other things in the works).”

The article does not address what many consider the core rationale of supporting the FairTax. The FairTax is a fundamental change away from taxing productivity (income). The income tax has been wrong headed since its inception. We live in a capitalistic society wherein we use taxes to influence behavior. Taxing “income” is simply counterproductive. As far as the progressiveness issue goes, there is no question that the wealthy spend massively more than the middle class. Some people love to use the “percentage of income” argument which is divisive and a ploy to create class warfare. The beauty of the FairTax is that it will greatly reduce all the nonsensical class warfare due to the fact that citizens will no longer have “income” issues so involved in the political spectrum. We will get away from much of the “bring the bacon home” arguments where the focus is on the massive giving and taking of a gargantuan tax code that NO ONE can interpret consistently. The IRS has to be done away with. It has been used by both parties to abuse political foes. There is no “fixing” the Tax Code again. It has been “simplified” so many times that it has grown to over 70,000 pages of political mush. When a normal “Joe” has to fear his government, and pay a professional to prepare a tax return (that even the preparer does not know if it is corrcet) we have reached the pinnacle of idiocy. We need elimination not simplification of the Tax Code and IRS.

My comment on progressivity was incidental. It is just that the promoters say the tax is progressive and it is not as we commonly understand that. You apparently think that is a good thing.

The main thing that interests me is the “abolish the IRS” part. The article from the Fair Tax website indicates that the Fair Tax will cost slightly more to administer. It is just that the work will be done by 50+ revenue agencies. Over the years I have found that dealing with state revenue agencies can be both harder and easier than dealing with the IRS. It changes over time agency by agency. Having the same tax administered by 50+ different agencies threatens to be crazy making. Ultimately I think the IRS by a different name would be reinvented.

Most of the issues that end up creating controversy in the income tax exist in the Fair Tax. The big thing is that if you use goods and services in your business the tax is rebated. Similarly if money you spend is being used in your business it is deductible for income tax purposes. The Fair tax looks simpler now because people have not started gaming it. Do you think anybody who pays $30,000 for a car will not try to plausibly argue that the car is for business so they can get the $9.000 rebated.

A very large part of what the IRS does is collect the tax from people who flat out don’t pay amounts that are clearly due. The same issue will exist with the Fair Tax.

Finally just as Congress cannot resist tinkering with the income tax, what is going to prevent them from starting to carve out exemptions and exclusion from the Fair Tax?

You continue to avoid the biggest issue that the FairTax addresses, the taxation of productivity. Our backwards tax system is used to punish and modify behavior. If we want less of a thing, then we tax it. So, why are we taxing income when everyone wants more?

When these taxes (payroll) are removed from the cost of manufacturing and services we will gain strength in our global trade positions.

No one has claimed the FairTax will be perfect. No tax system will be, and no tax system will be such that it can not be cheated. In regard to administrative costs, I will research that further (I believe there is some conflicting data). In any event, that number is miniscule in comparison to the $400 Billion of annual compliance costs to the TAXPAYERS.

If the tax system was more fair and less complex, there would be less cheating simply due to that alone. I can certainly agree that dealing with state level agencies can be harder, but in my experience the reasons were due to the states trying to use the federal tax code as a model. There can be no argument in regard to complexity when comparing the current code with the FairTax. I have considered the fact that there will be “gaming” of the FairTax, but so what? You can’t design a system that forces people to pay taxes that won’t be gamed. So to trying to hang that on the FairTax alone is lame.

We have a once in a century opportunity to make a fundamental change of tax systems. We need to stop taxing income and tax consumption. Get the government out of our personal and business lives to the maximum extent possible. Americans will respond with encouragement and ask why we put up with this monster called the tax code for so long. The only way we can ever make this kind of change is with the taxpayer demanding it be changed. Politicians love the mess we have now. It is their best source of buying votes. This is change I believe in!